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  • Writer's pictureJerry Ipsen, CFE, MBA

Fraud and Supply Chain Management

Updated: Sep 29, 2020

While the numbers have been updated since Robert Victor first published his article, “How to Prevent Theft & Fraud in Your Supply Chain,” the tenets remain the same. Supply chain management has become extremely complex and with the advent of automated technologies such as digital monitoring, the entire concept of supply chain management has become much more than the scheduling of production, assembly, and shipping. As Victor said, “With complexity comes more risk of fraud and theft, unfortunately, but it also supports more extensive measures for detecting and preventing fraud.”

How Fraud Has Affected the Supply Chain

According to the ACFE (Association of Certified Fraud Examiners), an individual may commit fraud for one of three reasons: pressure, opportunity, or rationalization. The average shrink rate or loss percentage in the retail industry is 1.6%, according to the 2020 National Security Survey. This equates to over $61 billion in annual losses for retail businesses altogether. Keep in mind, these numbers are up since Victor first published his article in 2019. At the time of his writing, Victor relied on reported results from 2018. Unfortunately, the numbers since that time have increased from $49 billion in total losses to over $61 Billion. A 24.4% increase in just 2 years.

According to the 2020 National Security Survey, the occurrences of fraudulent retail sales is now being reported as 49.3% of in-store sales; 26.1% for online sales, and 18.8% for sales that took place online, and the merchandise was later picked up.

Companies can reduce fraud in their supply chains by eliminating opportunities for theft. This is accomplished by implementing strong anti-theft, zero-tolerance policies for all employees with the support of senior management. Other ways for companies to combat opportunity-based fraud is with adequate risk monitoring and evaluation methods such as specially placed CCTV cameras and exit searches for employees and visitors leaving the premises. In the case of exit searches, please check with your company attorney for what procedures and to what degree are they allowable by law.

Detecting Fraud in the Supply Chain

According to the Association of Certified Fraud Examiners (ACFE), the most effective way to detect fraud in the supply chain is to solicit and encourage tips through hotlines, and then investigate them. The ACFE’s 2020 “Report to the Nations” noted that tips are the most common method for the initial detection of fraud as the ACFE report states that 43% of fraud schemes were detected by a tip. Half of those tips came from employees with the balance of exposed fraud cases were a result of diligent customers, vendors, competitors, and a few others. Internal audits for the same period accounted for only 15% of the detected total cases of fraud.

Victor writes, “Another commonly recommended way to identify where fraud may be happening in your supply chain is to conduct surprise audits and inventory checks, of both your vendors and workforce.” While Victor mentions surprise audits, B. Ray Mize, an experienced auditor of many years, states in his article “Vendor Audit” that he disagrees with the concept of surprise vendor audits as the opportunity for strong emotions and ill will is often created, leaving the vendor less likely to be compliant. Sometimes as Mize stated, the vendor is not there or even available. Mize addresses the issue by providing the vendor a two to three-day notice. With that said, Victor does make the point of unscheduled audits and inventory checks within the company can be effective. Victor is also correct that the best way to handle employees who know how to work “the system” is to vary the timing of such audits and by conducting unscheduled audits. I agree, as results from unscheduled examinations are less likely to be skewed, thus improving one’s chances of identifying the source of any fraudulent activity.

Robert Victor in his article relies on several industry experts as he should for their knowledge of supply chain management, the risks of fraud, and the use of strong internal controls. Their comments are as follows:

Monica Eaton-Cardone, co-founder and COO of Chargebacks911, says that the most important thing about identifying theft and fraud in your supply chain is understanding where the risks are. “Start by regularly conducting evaluations and risk assessments to analyze potential factors that can negatively affect the company… analyze the workplace and look for any uncertainties, events, and hazards to determine what could go wrong (i.e., use a risk-profiling questionnaire),” she said. Once you have an idea of the risks your company is exposed to, you should outline these risks for your team and give them directives to reduce liability with continued tracking and prioritization of the ones that impact your workplace the most.

Keeping the Supply Chain Free From Fraud & Theft

According to Mark Struss, Practice Director of manufacturing operations at Patina Solutions, “The key to preventing losses in the supply chain is communication, enforcing basics, logical policies, and leveraging technology.” Struss outlined how these four areas help minimize supply chain fraud:

  • Communication: It’s important to communicate to the organization through the mission statement, handbook, or other means that integrity is a non-negotiable value.

  • Enforcing Basics: Rigorous adherence to GAAP — such as enforcing the three-way split between the requestor, the receiver, and accounts payable — is important, as is the three-way match of PO, invoice, and verified bill of lading.

  • Logical Policies: Create logical policies that limit opportunity and reinforce integrity values. Ideas such as using only clear trash bags and, depending on the size and value of the components, lunch box inspections at clock-out may make sense.

  • Leveraging Technology: Cameras in key places, barcodes to help in transactions and accuracy, and monitors in the common areas that scroll the mission and values all reinforce the basic outline. Do not rely on technology to create the system or to stand alone. It could backfire by being turned against you to make a small incident more extensive.

For Calloway Cook, founder of Illuminate Labs, “the best way to negate fraud and theft in your supply chain is to choose a fulfillment partner with an inventory management system that counts each individual SKU.” Most fulfillment companies will just use an estimate that is based on pallet count. While maintaining the exact numbers of SKUs is time-consuming, the company is left with incomplete information if individual SKUs aren’t monitored. “I actually had a shipment arrive 8% short once, and was able to negotiate a refund with my supplier. This would have not been possible without a fulfillment partner which counts each SKU,” Cook explains.

CJ Xia, VP of Marketing & Sales at Boster Biological Technology, adds that supply chains should “use barcode and asset tracking software to improve inventory control. In case of fraud or theft investigation it becomes possible to track where an item is, how it got there, and who had access to it last,” he said. Monica Eaton-Cardona from Chargebacks911 agrees: “You should have sourcing visibility by using barcode technology to track your inventory and make sure your inventory is regularly updated.” Xia also says that “divide and rule” is the key to prevent employee theft in the supply chain. It’s a mistake to “give control of the whole process, e.g., ‘purchase department’ to one person. For example, you should separate the functions of payment, receipt, and preparation of purchase so that no single person has the power to oversee an entire transaction,” he said.

Stacey Kane is the business development lead at Easy Merchant, where, to help prevent fraud and theft, they “keep a detailed database of all [their] products and stock levels, which helps [them] know exactly how much [they] have and if anything goes missing.” Kane explains further, “Regular stock checks and audits are also done at the warehouse so we can ensure everything matches across the board and that our website stock levels correctly match what our database says.”

Where some have failed to include fraud and supply chain management in the same sentence, Victor does the subject justice. Robert Victor wrote the original article in 2019 and is with Hollingsworth, LLC located in Michigan.

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